Updated on 02.11.16

What Should I Do With My Newfound Money?

Trent Hamm

A guide to figuring out how to handle that unexpected windfall or big raise at work.

It happens several times in the lives of most adults. For some unexpected reason, you suddenly have more money than you had yesterday.

Maybe that money comes in the form of a better-paying job or a raise at work. Maybe it’s a nice workplace bonus. Maybe it’s an inheritance. Maybe you bought a lottery ticket and won $100,000. Maybe you won a lawsuit.

Whatever the reason, you now have access to much more cash than you did before.

But what do you do with it?

Obviously, throwing this cash around like a wild person isn’t going to really change your life. Unless you suddenly have truly infinite money, spending that money impulsively, especially on any sort of big purchases, is an awful idea. You’ll spend through your newfound money so quickly that you’ll be back to where you were before almost without skipping a beat.

The thing is, a windfall or an increase in income is a great opportunity to make your life better for the long haul. Many people simply see it as a reason to buy a new car much earlier than they otherwise would or to go on a few expensive trips… but then the money’s gone and you have the same problems you’ve always had.

What follows is an explanation for how to turn almost any windfall or pay increase into lasting positive change in your life.

Now, before we dig in, let’s be realistic. We’re not talking about finding a $20 bill in a parking lot. The advice below doesn’t begin to make real sense unless you are talking about at least a couple hundred dollars. If the amount is smaller than that, use it to buy groceries and pick up some bulk items – just give yourself a little more breathing room in your monthly budget for a little while.

So, here’s the game plan for your windfall.

If This Is an Increase in Your Yearly Income for the Foreseeable Future…

In other words, is this windfall you’re receiving in the form of a raise that will increase your weekly and/or annual pay for as long as you hold down your job? Maybe it’s an annuity or some kind of payment from a trust fund that will be doled out over a long period of time.

Whatever the reason might be, if your annual income is going up for the foreseeable future, you need to take different steps than if you were receiving a lump sum.

First and foremost, do not inflate your lifestyle! This is the most important thing you need to do if your income goes up. Do not immediately adjust your spending to absorb that new income!

Instead, what you need to do is continue to live on your previous income. Don’t change your spending one little bit. Don’t spend more on cars, on housing, on food, on anything. Just keep rolling along as before.

The reason for that is that you already know how to live day-to-day on your previous income, but it’s also likely that your financial house isn’t perfect. Maybe you have some debt hanging around – a student loan, a credit card debt, a car loan, or a mortgage. Maybe you’re not really saving for retirement. Don’t feel alone: This situation describes the vast majority of Americans. They get by in a day-to-day fashion, but there are holes in the foundation of almost everyone’s financial house.

Your goal should be to use that increase in income to start patching up all of those holes.

First of all, keep making minimum debt payments – or even extra payments – just as you were from your normal income. Don’t assume that your income increase is now going to cover your debt payments, because that’s effectively inflating your lifestyle.

Instead, use your extra income to make “bonus” debt payments, starting with your highest-interest debts. If you’re now bringing home an extra $100 per paycheck, make an extra $100 payment toward your highest-interest debt. Eventually, you’ll pay it off and you can move on to the next one.

There’s a bonus here: When you get rid of that debt, you’ll no longer have to make the minimum payment any more. You’ll actually have more breathing room in your normal paycheck, too. You can then really start hammering down on the next debt.

If you don’t have any debts and don’t have anything coming up in the near future that might cause debts (like a car purchase), consider using that money to directly save for other goals. For instance, you might sign up to have that $100 per paycheck directly put into a 529 college savings plan for your kids, or maybe you have it put directly into a Roth IRA for your own retirement.

When you do this, you use that money to fix all of those little worries you have about the future without negatively impacting your day to day life. When you hear the phrase “pay yourself first,” this is exactly what they’re talking about. You take some of the money right off the top, before you ever have the chance to spend it, and you use it for improving your financial foundation. Soon, that foundation is strong – you’re free from debt (meaning you don’t have those minimum payments any more) and you’ve got savings for the future. Your ship doesn’t have any leaks any more.

If This Is a One-Time Bonus…

Of course, many financial windfalls don’t come in a steady trickle like that. They arrive in a single lump, in the form of a bonus at work, an inheritance, or some winnings from a contest or other event.

In those situations, people often don’t directly inflate their lifestyle, especially if the amount is relatively low. Instead, they often simply splurge on a thing or two, spending it on whatever their desire of the moment happens to be, and when that desire is sated, their life quickly returns to the way that it always was.

For some, that quick burst of “fun” is enough. An amazing weekend getaway or a huge new television or a new car something like that might bring a lot of joy to a person, well worth giving up any potential lasting changes that the money could bring.

However, for many people, that burst of joy is fleeting. Their lives return to the same old thing, with the same old worries.

For me, a far better use of that money is to alleviate some of those “same old worries” and reduce the stress of life moving forward.

Here’s how to do that.

First, Clear Your Financial Plate

The most valuable thing you can do with a pile of windfall cash is to simply clean your financial plate a little bit. At the top of that list are two key things that many people still have on their plates: high-interest credit card debt and no emergency fund.

First of all, what’s an emergency fund? An emergency fund is simply some cash stowed away in a savings account somewhere that can be tapped in a time of crisis.

Your car breaks down? Ordinarily, that might be “panic mode” time, but if you have an emergency fund, you just call your bank and move some cash to your checking account and it’s easy. Lose your credit cards or get hit with identity theft? You can use that cash to get by for quite a while, even though your credit card accounts may be frozen. That’s what an emergency fund is – it’s secure and easily-available cash for all of life’s unexpected problems.

My recommendation is that every working American should have – or should be building towards – a $1,000 emergency fund in their savings accounts as a first financial priority. That emergency fund should be larger when you have some of your other financial issues taken care of, and that’s especially true if you have dependents.

So, first thing, make sure that you have $1,000 in your savings account for emergencies.

Next, look at your high-interest debts, especially your credit cards. Any debts you have that are over 10% interest need to disappear as fast as possbile because they are huge drains on your financial state. So, if you have any of those, pay those down before even considering any other steps. There’s virtually nothing you can do with your money that will earn a guaranteed 10% return on it, but that’s effectively what you get from eliminating a 10% debt.

For most people, these moves alone will wipe out their entire windfall. That might seem like a sad use for that windfall. Didn’t they get anything fun out of it?

The truth is that moves like these don’t give you a burst of joy, but they take the negative edge off of life. You don’t have to get a sick feeling in your stomach if it sounds like your car isn’t going to start. You’ve got this. You don’t have to dread opening the mailbox or looking at a credit card statement that you can’t pay off. You’ve got this.

Over time, I’ve learned that this kind of mental relief adds up to way more than any kind of splurge. It just makes day to day life better, something no splurge can really do.

But what if you have an emergency fund and you don’t have any high-interest debts? Or what if your windfall is far bigger than those things (though you should still wipe out your debts and build an emergency fund first)? What then?

Next, Evaluate Your Future Plans

This is the point where the old, familiar advice about windfalls comes into play. Don’t touch it for six months. Just leave it alone. Let it sit. Keep living life as normal. Let the “new” wear off. Let all of the impulsiveness run out of your system before you start tapping that money.

If you have a large enough sum that you’ve paid off your debts and you have a healthy cash emergency fund and you still have a lot left over, you owe it to yourself to be a little patient and careful about how you use the rest of it.

Your first order of business should be to think about what you truly want most in your future. The thing is, different people are going to come up with very different things. My vision of the future that I really, really want for myself is going to be substantially different than your vision of your future that you really, really want for yourself.

Mine involves “retiring” as young as possible, with enough money invested so that Sarah and I can maintain our current lifestyle without drawing down that investment. By “retiring,” I really mean moving on to doing things with my time that don’t have income generation as a major motivating factor. Sure, I might make money from the things that I do, but if I don’t, that’s not really a deal breaker any more.

But, for us, that borders on a long-term goal. My target date for such a “retirement” is when our youngest child is ready to move out and he’s just barely in elementary school.

This brings us to the next part of defining your future plans: What’s your timeline? When do you expect to actually move forward and need the money for the big thing you’re thinking about?

For example, let’s say your dream is to start a business. You might have enough money to launch it right now. Maybe you want to buy a house, but you don’t have quite enough for a down payment, but with those credit cards out of the way, you’ll be there in a year or two.

When you’ve got your goal and your timeline figured out – and those short-term impulsive plans have faded into the woodwork – now’s the time to look at your investment options.

If Your Plans Are Short-Term (Less Than, Say, 10 Years)…

If your plans are within a 10-year window, your best move with that money is to put it in a secured deposit account – in other words, a normal savings account at your local bank. If you’re very sure about your timeframe, you can put it in other secure investments, such as certificates of deposit (CDs).

The reason for this is that almost any other investment has too much volatility within that relatively short timeframe. There’s a significant chance that almost anything else that you invest in (outside of these types of highly secure accounts) will be worth less in 10 years than it’s worth right now – and especially if your term is much less than 10 years.

That’s not to say that they’re bad investments. The problem is that they’re volatile. There are times when the price of those investments skyrockets… and there are other times where it falls to earth like a meteor. The problem is, it’s almost impossible to tell when it’s going to rocket upwards or downwards.

Over the long term, most things that have an obvious intrinsic value tend to go upwards. Their big jumps upward are a little bigger than their jumps downward and that adds up.

I like to imagine someone climbing up a hill with a bunch of boulders on it. Most of the time, you’re going upwards, right? But, sometimes, you’re going to be on top of a boulder and you’re going to have to get down off of that boulder to the ground in front of you and then go up to the next one. You’re going to have to go down for a while and if you’re looking at just how much higher you are than you were earlier, you’ve lost ground. That’s volatility.

Investments do the exact same thing. If you look at investments really broadly – like the stock market as a whole – it looks almost exactly like a mountain climber trekking up a slope that’s littered with boulders. The stock market reaches little peaks all the time – where the “mountain climber” reaches the top of a “boulder” – and that’s followed by dips – where the “mountain climber” goes back down off of the other end of the boulder. Overall, the trend is upwards, but if you look at just the segment where the mountain climber is dismounting from the boulder, it looks like a steep drop.

When you buy in for the long term, you’re giving your investing “mountain climber” plenty of time to climb up and dismount several “boulders.” Overall, your climber is going to end up quite a bit higher than where you started.

When you buy into a volatile investment for just a little while, though, your investing “mountain climber” doesn’t have the time to climb many boulders. In fact, if you happen to invest when your climber is already at the top of a boulder, you’re going to lose money for a while, and if you’re not going to have your money in that investment for very long, you’re going to lose money on that investment.

A much better approach for short term investing is a very secure, very steady, and relatively gentle upward trail. That’s exactly what an FDIC-insured savings account gives you. Your money is about as safe as it can humanly be in that account. It’s insured against bank failure up to $250,000. It’s not going to lose value, but it will gain a little bit of interest along the way. It will move upward slowly, steadily, and gradually, but it won’t lose a dime.

If your money is going to be needed in the next five years, put it someplace really safe and boring, like a savings account.

If Your Plans Are Long-Term (More Than, Say, 10 Years)…

This is the situation where you can take on some of the “boulders” that I described above.

Over a longer period of time like this, you’re going to be in the market for long enough to go through at least a couple significant upward trends and a couple of downward trends – and maybe more. On the whole, though, if you invest wisely, your investment value will go up significantly over that timeframe.

How can you do that? You do that by investing in something volatile, but doing it as broadly as possible.

In other words, if you’re going to invest in stocks, don’t just buy stocks in one company or in one industry. Go as broad as you possibly can. Buy a little bit of everything, so that you’re not betting on one company or one sector, but on the idea of human effort and productivity and ingenuity as a whole. The easiest and most cost-effective way to do this is to use an index fund, which is basically a cheap way to buy a little sliver of tons and tons and tons of stocks at the same time. I personally use the Vanguard Total Stock Market Index for this.

There are similar index funds for other things, like real estate and commodities, too. My advice is, if you’re not sure, diversify and buy a little bit of all of it. Put some in a stock index fund, some in a real estate index fund, some in a commodities index fund. All of them are going to ride up and down over the next 10-plus years, but some will go up while others go down and vice versa. Overall, the whole thing will slowly climb.

How do you do this? I simply use Vanguard for all of it. They make it all really easy – about as easy as using an online bank. You can go through, look at options, choose what you want, and it’s done. They make it all a breeze.

What About Retirement?

Some people may just want to save all of this money to secure a traditional retirement. What exactly do you do with a windfall when you want to set aside all of it for retirement?

If it’s less than $5,500 and you’re not already contributing to an IRA, you should use it to contribute to an IRA. If you’re eligible – and it’s highly likely that you are – you should specifically contribute it to a Roth IRA, as that will allow you to take out all of the money in retirement without paying taxes on the gains, which is a really nice benefit. You can easily sign up for a Roth IRA through Vanguard, which is where I have mine.

What if you have more than $5,500? In that case, I’d set it aside in a savings account and then maximize my Roth IRA and 401(k) contributions in the coming years. Change your retirement plan at work to maximize your contributions and then, if you need to, use the money you have set aside to make up for any shortfalls in your day-to-day spending. Also, at the start of each year, take enough from that money you have set aside to make a maximum contribution for the year to your Roth IRA and your spouse’s Roth IRA.

If these items aren’t clear to you, a great place to start for retirement planning information is The Bogleheads’ Guide to Retirement Planning, which is my single favorite book on retirement planning issues.

Final Thoughts

The advice above should cover almost everything that you might do with a sudden influx of cash, but if you find yourself in a corner case that’s a bit unusual, it’s never a bad idea to talk to a financial planner about it. I recommend seeking out a fee-based financial planner who isn’t driven by commissions. Here’s my personal guide to finding a great financial planner.

Regardless of where this road leads you, if you follow the advice above, you will find yourself in a place where financial worries become less of a part of your life, and that can only lead to greater joy and personal freedom.

Good luck!

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